An Examination of IFRS and Its Contribution to the Financial Crisis

This report analyzes the contribution of International Financial Reporting Standards (IFRS) to the global financial crisis, focusing on the role of fair value accounting. It examines how fair value, asset securitization, derivatives, and loan loss provisions impacted the crisis, particularly within the banking sector. The report begins with a definition of the financial crisis and its global spread, highlighting the shortcomings in financial reporting that made it difficult for stakeholders to assess asset values and associated risks. Despite standard-setting efforts, gaps in full disclosure persist. The report aims to analyze the origins and emergence of the financial crisis, and how IFRS contributed to it, with a primary focus on the impact of fair value accounting, which the author argues played a significant role in the crisis. The report also includes references to the Great Depression and the role of incorrect accounting policies, such as those adopted by Lehman Brothers.

ABSTRACT
As the title suggests, this report has helped in the detailing the relationship of International
Financial Reporting Standards and the global financial crisis. The paper has examined the role of
the fair value accounting in bringing the financial crisis at the global level. It has been
scrutinized as to how the financial reporting for four major items namely fair value, asset
securitization, derivatives and provision of loss of repayment of loan have contributed or played
the major role in bringing the financial crisis at the global level. Banking sector has been found
as effective and active during the period of financial crisis. The report has been started with the
definition of the financial crisis and how the same have spread globally. In the current reporting
standards although many steps have been taken by the standard setting bodies for the correct and
true representation but still there remains gap in the full disclosure due to which the stakeholder
of the company including the potential investors finds it difficult to have the judgment about the
value of the particular asset and the risk associated with that asset if any. In spite of the fact that
the accounting standard boards issues the accounting standard in the system but it is the duty of
the company for ensuring the financial stability in the system.
INTRODUCTION
The financial crisis has occurred globally and has affected the economies of all the countries in
the world. The crisis has been started from the financial year two thousand and seven and has
continued and has ended up in the financial year of two thousand and nine. It has brought many
collapses in the different industry. Some of the example is Lehman Brothers, Commonwealth
bank, One Tel, HIH Insurance and so on. The financial crisis has resulted mainly in the collapse
of the banking sector which in turn lends the money to the companies for carrying out their
business. Due to this collapse, the companies have also faced the period of recession.
The report has been framed with two major aims. First aim is to analyze the origin of the
financial crisis and to discuss as to how the financial crisis have happened and emerged. The
second major aim is to analyze as to how the international financial reporting standards have
contributed towards the financial crisis. Over the above these two aims, there is one primary aim
of this report. It includes the analysis of how the fair value of accounting has led to the financial
crisis in a large scale. As the financial crisis has first affected the banking sector, therefore

wherever necessary the banking sector has been taken into consideration. The report has then
ended up with the proper conclusion and recommendation thereon.
FINANCIAL CRISIS
Financial crisis in the common lay man language will be referred to as the situation where the
assets of the company loses their value and the liabilities are required to be paid due to which the
net worth at the end of the reporting period will be negative. Many financial crises have been
occurred during the history of the world. One has happened in the history when Second World
War was about to begin and has been termed as the Great Depression period. In the given case,
the financial crisis of the finance year 2007 has been considered (Beaver, 2016). The crisis at one
place has led the origin of the crisis across the world. The circumstances which have led the
financial crisis have been detailed as under:
- At first there has been no regulation which entails that there shall be full disclosure of the
accounting policies and the estimates adopted in the financial statements for the particular
year end. Before the financial crisis of the year 2007, there has been no such policy of
the full disclosure due to which the wrong information has been provided to the investors
including the potential investors of the company. For instance in case of Lehman
Brothers, they have been adopting the wrong accounting policy of reverse repo and
deliberately keep their revenue inflating so that maximum investment can be gathered
from the investors in lieu of higher returns and also to have the maximum funds from the
banks. But the actual picture has neither been provided by the company nor the auditors
due to which in one single quarter the company has reported the net loss and in third
quarter has filed for insolvency. This has been majorly due to the adoption of incorrect
accounting policies (Katz, 2010).
- Secondly, the fair value accounting has been adopted in preparing the financial
statements of the company. The depression that has come in the early year of 1930 has
also been derived from the adoption of the fair value of accounting. Due to the fair value
of accounting the assets and liabilities are generally overstated so as to have the higher
reported profits and which in turn after sometime falls down very quickly leading to the
collapse of the industry.

IFRS CONTRIBUTION
IFRS is defined as the International Financial Reporting Standards and these are the standards
which are required for making the accounting entries in the books of accounts and for making the
necessary disclosures in the financial statements of the company. These are prepared and
finalized by the accounting standard setters.
The IFRS has contributed much to the financial crisis. The statement is true and effective. It is
because the IFRS has given the method of valuation of the assets by name of the fair value
method and which in turn has led to the wrong presentation of the value of assets as reported in
the financial statements. Similar has held in case of the liabilities.
Now the concern is how the fair value of accounting has led the financial crisis? Why it has been
resorted again even after facing the great depression period and even after the suspension made
by the then president Franklin D Roosevelt?
As per the provisions of IFRS, assets and liabilities relating to the financial instruments shall be
recognized at the fair value. Fair value is defined and measured through two ways. One way tells
about the assets and other way tells about the liabilities. Former will be valued at the price which
will be received at the time of selling of an asset and the latter will be valued at the price which
will be paid for transferring the liability (Barth, 2014). The major contention regarding the
treatment of fair value accounting as wrong and major leader in bringing the financial crisis is
that the company through this measure does not provide the actual position and value to the
investors and other stakeholders of the company. It means the quality of the financial
information provided is not up to date and useful for the users of the financial statements. Other
stakeholders include the potential investors, government authorities and etc. Relevance is one of
the fundamental features of the financial statements. If the information provided is not relevant
then it will not serve the purpose. The same has happened in case of the fair value accounting.
The users have made the view that the information given is not relevant. And the value relevance
is the most important thing in the financial information (Hitz, 2016).
The other contention regarding the adoption of the fair value adoption is that there is the high
volatility in the amount of the assets and liabilities reported in the financial statements of the
company. Volatility is referred to as the change in the value of assets and liabilities. In case of

the fair value accounting and measurement, the difference between the book value and the fair
value is recognized in the statement of the profit and loss as unrealized gains or losses and the
same shall be added to the value of the financial instruments including the assets and liabilities
thereon (Landsman, 2015). Due to this volatility in the figures of the assets and liabilities, the
investors and the users of the financial statements will have the idea that there will be the
chances of having more profits in less time because of high volatile nature of income. As fair
value deals with the mark to market, there will be the probability of having gains.
Thus, in this manner, IFRS reporting framework have contributed towards the financial crisis
from the period of 2007 to 2009.
CONCLUSION
The financial crisis has led many of the companies collapsed during that period across the globe.
The major roles in the financial crisis have been played by the fair value of accounting. The fair
value of accounting has brought the collapses two times in the history of the World. One has
come in the period from 1929 to 1933 which is referred to as the great depression period and the
other one has come in the year of 2007 to 2009 due to which the companies are still as on date is
coping up with the collapses.
To conclude, the IFRS relating to fair value has significant role in bringing the financial crisis
across the globe.
REFERENCES
Barth, M. E. (2014), “Fair value accounting: Evidence from investment securities and the market
valuation of banks”, The Accounting Review, 69(1), 1-25.
Beaver, W. H (2016), “How did financial reporting contribute to the financial crisis?” European
Accounting Review, 19(3), 399-423.
Hitz, JM (2016), “Value-relevance of banks’ fair value disclosures under SFAS No. 107”, The
Accounting Review, 71(4), 513-537.

Katz D, (2010), “The relevance of the value relevance literature for financial accounting standard
setting: Another view”, Journal of Accounting and Economics, 31(1-3), 77-104.
Landsman, W. R.. (2015), “Including estimates of the future in today’s financial statements”,
Accounting Horizons, 20(3), 271-285.